Futures Exchanges, referred to herein also as an “Exchange”, such as the Chicago Mercantile Exchange Inc. (CME), provide a marketplace where futures and options on futures are traded. Futures is a term used to designate all contracts covering the purchase and sale of financial instruments or physical commodities for future delivery or cash settlement on a commodity futures exchange. A futures contract is a legally binding agreement to buy or sell a commodity at a specified price at a predetermined future time. An option is the right, but not the obligation, to sell or buy the underlying instrument (in this case, a futures contract) at a specified price within a specified time. Each futures contract is standardized and specifies commodity, quality, quantity, delivery date and settlement. Cash Settlement is a method of settling a futures contracts by cash rather than by physical delivery of the underlying asset whereby the parties settle by paying/receiving the loss/gain related to the contract in cash when the contract expires based on a reference rate such as interest rate, exchange rate or index rate or value which is substantially out of the control of the parties.
Typically, the Exchange provides a “clearing house” which is a division of the Exchange through which all trades made must be confirmed, matched and settled each day until offset or delivered. The clearing house is an adjunct to the Exchange responsible for settling trading accounts, clearing trades, collecting and maintaining performance bond funds, regulating delivery and reporting trading data. Essentially mitigating credit. Clearing is the procedure through which the Clearing House becomes buyer to each seller of a futures contract, and seller to each buyer, also referred to as a “novation,” and assumes responsibility for protecting buyers and sellers from financial loss by assuring performance on each contract. This is effected through the clearing process, whereby transactions are matched. A clearing member is a firm qualified to clear trades through the Clearing House. In the case of the CME's clearing house, all clearing members not specifically designated as Class B members are considered Class A clearing members. In the CME there are three categories of clearing members: 1) CME clearing members, qualified to clear transactions for all commodities; 2) International Monetary Market (IMM) clearing members, qualified to clear trades for only IMM and Index and Option Market (IOM) commodities; and 3) IMM Class B clearing members, solely limited to conducting proprietary arbitrage in foreign currencies between a single Exchange-approved bank and the IMM and who must be guaranteed by one or more Class A non-bank CME or IMM clearing member(s). Note that a “member” is a broker/trader registered with the Exchange.
With respect to cash settled contracts, at settlement or otherwise upon expiration of the contract, the Exchange further facilitates the requisite exchange of value by computing value of the positions held by the parties with respect to the market value of underlying asset.
Accordingly, to create a new product, such as a new type of futures contract for a particular underlying asset, the Exchange needs to determine how to value the underlying asset for the purpose of settlement, when to list the new contract, or otherwise offer it for trading and how long it should trade for before expiring and settling. For contracts requiring physical delivery of the underlying asset, creation, trading and settlement of such contracts is not difficult assuming there is an adequate supply of the underlying asset to facilitate physical delivery thereof when required. Alternatively, if the underlying asset is relatively easy to value but difficult to physically deliver, such as where the underlying asset is an index or portion thereof, the delivery may be specified as cash settlement.